In most of Europe, privatisation has been more about raising money than promoting enterprise

A DECADE or so ago it seemed that privatisation would provide the cure for part of continental Europe's economic ills. Governments of all hues were following the trail blazed by Margaret Thatcher in Britain after 1979. By shifting assets from public-sector control to the disciplines of private ownership and the capital markets, huge economic efficiencies could be unleashed—and, not incidentally, large sums of money could be raised for state coffers.

The effects were dramatic. In Britain, companies in public ownership accounted for 12% of GDP in 1979, but only around 2% by 1997, when Tony Blair took office. By then, even the Socialist government in France had accepted privatisation (though it quibbled about the label). The 1997-2002 Jospin government presided over bigger sales than had its right-wing predecessors. It launched a $7.1 billion initial public offering of France Telecom in October 1997, and made a $10.4 billion secondary offering a year later.

Elsewhere in Europe, privatisation had also spread. Germany sold several assets, including successive tranches of Deutsche Telekom. Spain and Portugal have been eager privatisers: the former completed its sale of Iberia, the national flag carrier, last year. And privatisation has become not just a Europe-wide but a worldwide phenomenon. It accounts for 30 of the 35 biggest share offerings ever seen.

Today, however, the momentum in Europe has slowed. In several countries, including the Netherlands and Germany, planned privatisations of infrastructure—such as postal systems, airports and railways—have been postponed or cancelled. In Italy, Silvio Berlusconi's government, which was expected to be an enthusiastic privatiser, has made almost no progress. It has been stymied by debate over the political fall-out from further sales. In France, the election of a strong right-wing majority in parliament could give new impetus to a programme that stalled two years ago, but there is still deep political concern that the whole policy may backfire.

If privatisation has found its limits in the country that pushed it furthest, should others be more leery of it in future?

The lack of activity is partly due to a subtle but noticeable shift in European attitudes to privatisation. Britain, the pioneer, is seen as having gone too far with its sale of the railways and its questionable “private finance initiatives” in the country's health service and transport industries. The partial sale of the air-traffic-control system was also controversial.

A symbolic moment was the British government's decision last October to place Railtrack, which owns the rail network, into bankruptcy—in effect, renationalising it. There is also the postponement of plans to privatise Britain's financially troubled Post Office, the last big and important state-owned industry in the country. The question this raises in the rest of Europe is: if privatisation has found its limits in the country that pushed it furthest, should others be more leery of it in future?

Big-ticket items

The rate at which state assets have been sold has certainly slowed since the late 1990s. In 2001, according to a forthcoming article by Ladan Mahboobi of the Organisation for Economic Co-operation and Development (OECD), a modest $20.6 billion was raised from privatisations in OECD countries, roughly three-quarters of it in Europe. In contrast to previous years, no single deal raised more than $5 billion.

Paul Gibbs, an analyst with J.P. Morgan, uses a different methodology to calculate European privatisation receipts. He counts money actually raised in a given year, whether or not the underlying deal was announced earlier. Between 1990 and 2002, according to his figures, total receipts in Europe were an impressive $675 billion. But he reckons that only around $38 billion flowed into government coffers last year, from 103 separate deals, sharply down from the $104 billion raised in the peak year of 1998 (see chart 1).

This slowdown was not primarily caused, as it has been in Britain, by governments running out of things to sell. It has three rather different reasons: first, weak stockmarkets; second, growing investor scepticism; and third, questions among investors and policymakers alike as to what constitutes true privatisation.

Weak stockmarkets have called into question the prospect for further sales, even though more deals are seen as a good way to restore public finances in countries (such as France, Germany and Italy) that have looming budget deficits. As arguments at last week's EU summit in Seville showed, these deficits are a growing threat to the EU's stability and growth pact. Privatisation proceeds are not supposed to count for stability-pact purposes, but there are ways round that prohibition.

The bursting of the market bubble in telecoms and technology shares has hit privatisation prospects hard, because such issues were among the largest. Companies such as Deutsche Telekom and France Telecom are so big that they could not be sold in a single transaction. Unloading new tranches of their shares was easy when prices were sky-high (as they were until mid-2000), but it is near-impossible now that those prices have crashed.

The dilemma is illustrated by Enel, Italy's biggest electric utility. The government sold 34.5% of it in November 1999, raising $18.7 billion. The company then went on an acquisition binge, paying high prices to buy into telecoms. Although investors have recently favoured utility companies, Enel's shares are now 30% lower than when they were floated. Last year, the government postponed the planned issue of a second tranche of shares that was due to raise billions of dollars. Until the share price recovers, the issue, itself a contributor to the price weakness, will remain on hold—and Enel will stay majority state-owned.

Another change in stockmarkets has adversely affected partially floated companies. Many investors now favour indexation—ie, they buy shares in proportion to companies' weights in a stockmarket index. Over the past 18 months, however, compilers of most country and pan-European stockmarket indices have changed how they calculate the weightings of companies that are partially floated. Only the traded portion, known as the “free float”, counts towards the market capitalisation that sets the share's weighting. Demand for shares in companies with less than 100% of their shares floating freely—many of them former state-owned telecoms companies and utilities—has thus fallen, putting more downward pressure on already weak prices. (The only big European country that does not use the free-float method for its index is France.)

Retail investors have good reason to be more sceptical about shares in privatised companies, many of which have brought poor returns. The idea of aiming share offerings at individual investors, rather than at a few big institutions, was embraced enthusiastically in Europe. The Italian treasury, for instance, saw it as a way to by-pass the traditional system of opaque share placements by banks. In Germany, the Deutsche Telekom sale in 1996 was seen as a big step towards developing an equity culture that might help to solve the country's looming pensions crisis.

Telecoms turmoil

The trouble is that several of these flagship sales have now turned sour. Investors who bought shares in France Telecom and Deutsche Telekom, for example, have been so burnt that they may not buy again for some time to come (see chart 2). This raises the question of what governments can do to rebuild investor confidence. In the meantime, they might have to find alternative ways to reduce their stakes. The Italian government, for example, is considering convertible-bond issues that raise money and hold out the prospect of investors eventually converting their principal into shares. This might be one way to escape its Enel dilemma.

In France, the newly elected right-wing government, with Jean-Pierre Raffarin as prime minister under President Jacques Chirac, has more privatisation options than most. Francis Mer, the new finance minister, has hinted that stakes in Air France and Thales, a defence and electronics company, could be sold, to raise up to euro5 billion ($4.9 billion). Last week, union leaders said the government was also considering selling half of its stake in Gaz de France, worth over $7 billion. And the state is sitting on a residual 10% stake in Crédit Lyonnais, a bank that was originally privatised in 1999.

Mr Gibbs of J.P. Morgan says that the government will probably try to make a case for each potential candidate based on its business. For instance, Crédit Lyonnais could be disposed of in a trade sale to another financial institution, rather than sold on the stockmarket. Telecoms sales are ruled out by market conditions, but a sale of Air France could be predicated on the airline's turnaround in recent years.

France is lucky because some of its biggest state-owned assets are utilities, now much favoured by investors. On top of Gaz de France, there is Electricité de France (EDF). The state-owned electricity monopoly is one of Europe's biggest companies, worth some euro60 billion and a prime candidate for a multi-tranche privatisation.

The problem with an initial offering is that it would have to be accompanied by a statement of intent on future sales, reducing the government's role in the business still further. But there is a big question-mark over the willingness of even a right-wing government to sell more than 49% of the company. Objections are based partly on the issue of EDF's nuclear liabilities. But there is also a strong belief, by no means unique to France, that certain industrial holdings remain “strategic”. Had the left won the recent election in France, it would certainly have pledged to keep more than 50% of EDF.

The idea of strategic holdings partly explains why only a small minority of privatisation deals has involved the complete retreat of government from the business being sold. Strikingly, no fewer than 24 of Europe's biggest companies by market capitalisation have some shares owned by a government. This suggests that privatisation is not always as clear-cut as it seems.

Consider the question of management control. The OECD reckons that governments in Western Europe alone have raised more than $400 billion from asset sales since 1990. But in many cases they have retained ownership control by selling only some of the equity via a flotation, or by retaining so-called “golden shares” that give veto rights against a takeover of the company.

On June 4th, the European Court of Justice issued a ruling against golden shares, decreeing that they should be allowed only in tightly defined circumstances. The European Commission had brought the case on the grounds that such shares were a restriction on the free movement of capital within the European Union. Last week, the commission said it might take countries such as Germany and Italy to court because of the golden shares they still hold in quoted companies.

But governments have many other ways of meddling. In Italy, Mr Berlusconi has recently imposed new managers at Enel and Eni, Italy's former state-owned electricity and oil monopolies respectively. The previous government's position was that it acted merely as a financial investor in these companies. But when the new government wanted to replace managers, it showed that the state was in reality a dominant owner. Minority shareholders might approve of the new managers, especially at Enel where Franco Tato, the outgoing boss, was a controversial figure. But in fact they had no say in their selection.

Italy has always had an ambiguous attitude to privatisation. Although more than $110 billion has been raised from sales over the past decade, successive governments have been wary of ceding full control. Two years ago, Confindustria, Italy's federation of industrialists, published a report on the effect of privatisation on the Italian economy. It found that only about one-third of the headline figure raised from asset sales was fully freed from state control.

In the mid-1980s Franco Reviglio, then chairman of Eni and a former finance minister, openly described privatisation as a good way of raising cash without losing control. That attitude is widespread even among Italy's numerous and powerful regional and municipal utilities. In Trieste, for example, a right-wing council has caused controversy by interfering in the affairs of the partly floated local utility.

Control, not ownership

Academic studies suggest that the role of state-owned enterprises in rich countries has shrunk from around 8.5% of GDP in 1984 to less than 5%. But the tentacles of government are far more entwined in business than these figures suggest. France offers perhaps the best example. It has had three big waves of privatisation, but the state still owns stakes in numerous companies, many of which are listed on the stockmarket. The stakes include 55.5% of France Telecom, 56% of Air France, 33% of Thales, and so on. Seven of France's largest 40 companies by market capitalisation have an important part of their equity owned by the state, including Renault, of which the government still owns 25%.

The French state also owns large non-listed companies across a wide array of industrial sectors, from chemicals to transport to energy. The biggest is EDF, already one of Europe's most controversial companies because it has expanded so aggressively outside France (it is now the fourth-biggest electricity company in Britain, for instance) even while remaining a protected monopoly at home. It has been at the centre of rows over the fair deregulation of Europe's energy markets. The rows are intimately linked with privatisation.

Economists and observers are divided as to whether privatisation has been less crucial to European structural reform than the gradual deregulation of such businesses as telecoms and energy, with the ensuing push this gave to competition. In Italy, which was slow to adopt privatisation, but then became an enthusiastic proponent in the mid-1990s, the effects of deregulation were further boosted by a restructuring of the banking system. State-owned banks were sold so as to sever much of the link between the state's finances and loans to industries. Officials at the treasury say this was a vital precursor to privatisation.

But the introduction of competition causes problems for state-owned companies that are due to be sold. Ms Mahboobi of the OECD comments that “competition and privatisation are sometimes uneasy policy bedfellows.” European competition officials have often pointed to EDF as an example of this tension.

EDF and the French government, its owner, would be happy for its domestic market to stay closed to competitors for as long as possible, in defiance of European rules. That way it can use its monopoly profits to cement an unassailable pan-European position. Already its forays into Spain and Italy have aroused strong opposition in those countries; and France's reluctance to liberalise its electricity market has been a source of friction with its European neighbours.

In continental Europe, privatisation has too often been a phrase that has disguised economic reality

Similarly, Italy's Enel has been strongly criticised for using monopoly electricity profits to buy its way into the telecoms sector in pursuit of a dubious “multi-utility” strategy. Critics say the Italian government failed in 1999 to combine privatisation with coherent deregulation of the electricity market. In Britain, the two were done together and the industry was broken into component parts that were designed to compete with each other. Enel remained an integrated company and, although it is selling some generating capacity as part of a belated and limited deregulation, it is well entrenched as the dominant force within Italy.

Arguably, only Britain has accepted the true retreat of the state from its biggest industries. Even there, this was done initially with caution. Golden shares were widely used, for example, to block the threat of rapid takeovers in the utilities sectors. In continental Europe, privatisation has too often been a phrase that has disguised economic reality. Governments have raised money, either for their own coffers or to boost the balance sheets of state-owned companies. But they have rarely forfeited control and have remained inclined to meddle.

Viewed positively, this leaves plenty of scope for future improvement. Governments have lots of room, as well as the budgetary necessity, to reduce further their interests in big companies. In time they might even give up control and leave companies to fend for themselves in emerging pan-European markets. The problem is that this is unlikely to happen quickly. Healthier stockmarkets are one prerequisite. But more urgently required is a political willingness to accept that, if it is to yield its fullest benefits, privatisation has to imply loss of control as well.